Why we must invest in ELSS

Way back in 1991, the government of India decided to encourage investments in equity by permitting a special scheme called the Equity Linked Savings Scheme (ELSS) to be floated by UTI and other state owned mutual funds.

The idea was that retail investors were unwilling to enter the equity market, and the tax incentive would attract people to invest in this scheme.

Yet, even at that time, this was not an exclusive limit – it was shared with PF, PPF and a whole host of other savings instruments. It is a mark of the success of this initiative that over 17 years later it is still a popular savings vehicle.

It is also a mark of the ignorance of people about equities that 17 years later, an article like this is of relevance.

Firstly, investments in ELSS should ideally be an outcome of disciplined systematic investment throughout the year… unfortunately most of us still wait for the March deadline to near before rushing in to make our tax investments. With saving tax the prime motive behind such investments, performance often tends to get compromised. Such eleventh hour approach will result in you giving up on the potential for generating impressive returns along with tax savings, especially considering the current state of the equity markets.

The stock market has witnessed one of its most volatile years in the recent past and many of the so called large cap stocks are currently available at a 50- 70 per cent discount. This combined with the fact that tax saving mutual fund schemes have a compulsory three- year lock in, make ELSS investments an extremely attractive option today. Prima facie, the three year lock- in period in ELSS investments may seem restrictive but it can actually work to your advantage. The fund manager of an ELSS scheme has the freedom to deploy a larger portion of the portfolio in equities (which have the potential to perform better over the long term) as he does not need to hold large amounts of cash to service redemptions.

Though equity funds may seem volatile in the short run, they have been known to create wealth and beat inflation in the long run. Therefore, ELSS is an ideal option for tax savings and wealth creation. And compared with other tax saving options, investments in an ELSS scheme have the lowest lock- in period (three years) when compared with other instruments like PPF (15 years) and NSC (six years).

The market currently has punished both good and bad stocks indiscriminately and going forward, as India emerges from this sentiment- driven battering, the fundamental strength of its domestic consumption is recognised and if present and future governments continue to invest significantly in infrastructure, we could see equity as an asset class benefiting from the current base effect.

In this context, what makes ELSS investments most attractive is the ability of an investor to always invest in the equity markets at a discount. For instance, if your annual taxable income is Rs 5,00,000 (therefore making you liable to pay 20 per cent income tax), you can in effect buy the Sensex at a price that is 20 per cent below its current 10,000 levels, that is at 8000 levels.

The market today is edgy and threatening to dip further, but rock- bottom valuations of good quality companies mean that it is unlikely to fall dramatically.

More importantly, there is scope for a big upside from current levels.

If you invest in an ELSS now, there is a good chance you are getting in near a bottom, and therefore stand to reap the strong returns that equities are known to give over a three- to five year period.

To conclude, ELSS schemes can prove to be an extremely attractive investment option for retail investors looking to combine benefits of tax planning and equity investments. Make your ELSS investments with a process driven fund house as compared to a ‘ star fund manager’ driven one. This is because during a three- year period, individuals may be fallible but processes have a better chance of success.

Last, but certainly the most important thing to note, is that ELSS is a tax savings option, but the principals of financial planning still apply. Please make an indepth analysis or consult a good financial adviser before choosing equity over other tax saving options.